Growing political noise in Brazil affects currency and yield curve – Morgan Stanley
RIO DE JANEIRO, BRAZIL – The latest mounting political noise is creating a negative scenario for the Brazilian real and risks further pressure on long-term interest rates amid rising fears of a less conservative fiscal approach, Morgan Stanley strategists said in a report Monday.
In the case of foreign exchange, strategists cited an already loaded level of positioning favorable to the Brazilian real, expensive valuations and heightened sensitivity to dollar fluctuations abroad as weighing against the currency, with the real’s risk/reward undermined despite the prospect of the Central Bank raising interest rates.
“We think that the currency will struggle to leave the R$5.00 to R$5.60 range in the short term and we see (the) options market as the most attractive,” they said, maintaining their recommendation to sell 3-month dollar/real puts with delta 25.
The spot dollar fluctuated around R$5.13 on Monday, down 1.5% on the day, thus returning some of Friday’s surge dictated by renewed spending fears.
In a separate study in the same report, the professionals pointed out that the Brazilian currency is among the most sensitive to the swings of the Chinese yuan, along with the Australian dollar, Colombian peso and South African rand.
Political issues may also affect the longer IDIs, which have been losing steepness against shorter rates both due to domestic monetary policy developments and the improvement in recent fiscal data.
The U.S. bank’s strategists assessed that growing disapproval of the government and the upcoming 2022 election suggest potential risks toward a less austere fiscal policy.
“This could ultimately create renewed upward pressure for long rates, notably with the excess term premium moving close to zero,” they said.
The rate spread between the January 2025 and January 2023 DIs, which reached 179 basis points in March, stood at 86.5 basis points this session but up 77 basis points from July 28.
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